Category Archives: Brazil

Breaking views | Brazil

Breakingviews | Brazil.

More measured optimism based on the available monetary options and government fiscal condition.


Measured optimism, an observation

A week ago I attended a conference about the future of the regulatory environment for the pré-sal oil developments in Brazil.  High-level oil executives, former directors at Petrobras and ANP, top journalists, and industry analysts, as well as one of the key government planners for the new regime were in attendance.  In the interest of candor, participants were instructed not to quote anyone directly.

All I will say is that those with the most experience in the oil business were the most measured in their enthusiasm for the regulatory changes.  Some were outright pessimistic about the ability of Petrobras and the incipient Petrosal to coordinate the hundreds partners involved in every block of pré-sal development.

Similarly, a few weeks ago, I met with numerous attorneys in São Paulo with experience negotiating cross-border investments for some of the largest businesses in South America.  The attorneys with the most experience in Brazil did not believe that foreign investments were going to meet all of the expectations of foreign investors.

As a young, soon-to-be attorney, I have comparatively little experience in Brazil.  In the sea of information about foreign investment and the pré-sal oil fields, I find myself looking to those with more experience for guidance.  And while many are measured in their big picture expectations for Brazil, all believe that on a personal-level developing experience and contacts here will prove useful.

Dollars and Sense

My guess is that most seasoned Brazil observers have a mental model that they use to think about exchange rate movements.  And no, I’m not talking about the Mundell-Fleming model.  I mean a softer, more intuitive model, depending in part on their memory (or lack of memory) of hyper-inflation, whether they are part of producer/exporter/tourists sectors of the economy and benefit from a weaker Real against the dollar, or part of the consumer/importer sector of the economy and benefit from a stronger Real.  The model is not much more than a set of assumptions about how short-term movements in the exchange rate affect the fortunes of various sectors of the Brazilian economy.

Underpinning that mental shorthand, is another set of assumptions about how currency markets and economies work.  The New York times prints rumors of the potential for a fundamental shift in currency markets:  The move away from the dollar as the both The Reserve Currency and The Oil Currency (the currency in which oil is priced and traded).  What is interesting is not the specific report and “secret talks” referenced in the article.  What is interesting is that many economists and political scientists believe such a move is inevitable.  The article notes:

“But the report caught the attention of investors because several economists had been predicting that at some point, the world’s oil exporters would start moving toward other currencies to limit exposure to the dollar.

“It won’t be easy to make such a shift; it’s a pretty unrealistic idea in the near term,” said Qu Hongbin, an HSBC economist in Hong Kong. But in the years to come, he added, China would be delighted if it could print its own currency to pay for oil, instead of having to earn dollars through exports.”

If such a move towards trading oil using a “currency basket” happened in the medium term, it would coincide with the development of the pré-sal oil fields and Brazil’s projected rise as a significant oil exporter.  Brazil’s oil would be traded using a currency basket.

It is hard to tease out how, and if, such a currency shift would affect Brazil and its oil sector.  One thing to keep in mind, however, is that the under the current government proposal, the pré-sal fields are to be developed by producers using Production Sharing Agreements, in which producers are paid in barrels of oil as a percentage of the total take.  That at least puts some of the currency risk (and upside) on producers.

There is a lot of uncertainty here.  It is, however, certainly something to watch and ponder.  Someday, perhaps sooner than we like, those mental models will need revisiting.

*** Update:

Dean Baker, writing for Foreign Policy, pushes back.  His point: the dollar is just a unit of measurement, and the unit of measurement doesn’t really matter.  If oil were priced in bushels of wheat or Euros,  it would not make a difference to the fundamentals of the oil market.

That much, anyway, I agree with.  But he goes on to imply that if Oil were priced in Euros, it wouldn’t make much of a difference in the currency markets.  He reasons as follows:

“… if all oil were sold for dollars, it would be a very small factor in the international demand for dollars, as can be seen with a bit of simple arithmetic. World oil production is a bit under 90 million barrels a day. If two-thirds of this oil is sold across national borders, then it implies a daily oil trade of 60 million barrels. If all of this oil is sold in dollars, then it means that oil consumers would have to collectively hold $4.2 billion to cover their daily oil tab.

By comparison, China alone holds more than $1 trillion in currency reserves, more than 200 times the transaction demand for oil. In other words, if China reduced its holdings of dollars by just 0.5 percent, it would have more impact on the demand for dollars than if all oil exporters suddenly stopped accepting dollars for their oil.”

This makes less sense to me.  One, he is comparing a flow variable (the $4.2 billion daily oil tab) with a stock variable (China’s $1 trillion plus currency reserves) to arrive at the conclusion that changes in China’s savings (a reduction in its stock of dollars) would affect the demand for dollars far more than the daily demand for oil.  Well, sure, it would. But only on the day that China reduced its dollar holdings.  On the next day, Oil would be king again.

Second, this doesn’t seem to take into account the basics of the currency or oil markets.  One, oil is the most traded commodity in the world (number two is coffee).  So if you need dollars to trade oil, you need dollars to participate in the largest commodity market in the world.  That increases the demand for dollars.  A single barrel of oil may be sold 40-50 times before being consumed.  So multiply that $4.2 billion by 40-50.  And in the countless oil trades that occur everyday, people are surely hedging their currency risk associated with any oil-related trade using options and futures, some of which are necessarily priced in dollars (whether they are buying or selling the dollars in the trade).  There is a lot of reason to think that the secondary hedging markets surrounding oil are substantial.  Global GDP is a little less than $50 trillion.  Yet daily turnover in the currency markets approaches $4 trillion.  What is that $4 trillion being spent on?  A good portion should be spent in relation to the largest commodity market in the world, certainly more than 4.2 billion or 1 percent.

And with that last fact — $4 trillion daily turnover in currency markets! — I realize that neither of us has any idea what is going on in the currency markets.

Congratulations, Rio! Home to the 2016 Olympics

A Olimpíada é nossa!  (Or Brazil’s, I guess).

Rio de Janeiro’s recent victory in the competition to host the Olympic Games is yet one more indicator of a city and country on the rise.  One of President Lula’s strongest arguments in favor of hosting the games is the fact that Brazil is the only top 10 economy not to have hosted the Games.

In line with my optimistic back of the envelope math, a scholar at Foreign Policy argues that BRIC countries are the best hosts for an event like the Olympics because: (1)  the infrastructure investments to be completed for the Olympics are truly needed and (2) higher growth rates mean future debt service is less of a burden.

Of course, the best reason to have the Olympics in Brazil is obvious.  It’s the Brazilians.  Warm, gregarious and sports-loving, the people of Brazil will be excellent Olympic hosts.  Parabéns prá vocês.

Back of the envelope math

The Brazilian economy is just under 2 trillion and its population is a little less than 200 million, making its GDP per capita around $10,000.  (Attention Americans: it is more expensive here than you think.)

The US just crossed the 300 million population mark, our economy is just over 14 trillion and GDP per capita is around $45,000.

What are the respective economies going to look like in 5 years?  In 10 years?  How is that going to impact the demand for high end legal services?  And how will those shifts in demand affect legal careers?

Play out a few scenarios in your mind.

US economic growth will be close to flat for the year.  Most of US economic growth since 2001 occurred in the finance and real estate sectors of the economy.  Both sectors shed a substantial amount of jobs and there are many qualified people to fill those jobs—if those jobs return.  The political will to reform health care (lifting a burden off the shoulders of American employers) and stimulate the green economy seems lacking.  It is hard to see where the economic growth will come from.  For attorneys, there will likely be growth in tech, bankruptcy and possibly alternative energy practices, but probably not at levels that fully replace the jobs shed in real estate and finance practices, while still providing opportunities for all recent graduates.

In contrast, Brazil economic growth is projected to be around 5 percent for 2010 (2009 economic growth is expected to be 1 percent, quite respectable during a global contraction).  Brazil is making substantial investments in infrastructure that will require at least some international suppliers and sophisticated financing arrangements, e.g. offshore oil wells and port upgrades.  Demand for commodities may continue to help Brazilian exporters and consumer confidence is still at a decent level.  It is easier to envision economic growth in Brazil.

If Brazil continues at its present pace, GDP could grow to $3 trillion in 7-8 years.  That would be an increase of 50 percent, which I can imagine that relatively easily.  Can you imagine US GDP increasing by 50 percent in 8 years?  Will we all have 50 percent more stuff in 2017?  I struggle to see that.

So if the Brazilian economy expands by 50 percent, do I think demand for high end legal services will grow by a corresponding amount?

No, I do not.  I think the demand for high end legal services could grow by greater than 50 percent in Brazil in the next 7-8 years.  As GDP per capita levels move away from $10,000 and toward $15,000, the kinds of projects businesses and people undertake change.  Projects grow more complex, cosmopolitan and expensive.  To better manage risk, financing structures will change.  All of this requires greater attorney involvement.  And hopefully, greater opportunities for young international attorneys.

Update: the first version of this post incorrectly stated that 2009 Brazil economic growth was projected to be around 5 percent.  Economic growth in 2009  will be around 1 percent.  Economic growth in 2010 is expected at 5 percent.  The post has been corrected with the proper estimates.

Where are the lawyers?

Who are the lawyers working in Brazil?  What firms are they at?

I recently joined the chorus and wrote that Brazil is a hot place to invest—whether through mergers and acquisitions, opening affiliates or through the purchase of debt or equity.  What is less appreciated is that Brazilians are also investing abroad.  In either instance, these transactions require high-level legal talent.  Much of this work is done in New York or London.  However, most would agree that deep commitment to a market requires a local presence.

Let’s have a look at the US and UK-based firms with offices or affiliates in Brazil. (Under Brazilian law, foreign firms are not allowed to advise on Brazilian law.  As a result, many foreign firms enter into agreements with local offices to advise on Brazilian tax, civil and regulatory matters).  The list that follows is alphabetized—not ranked—and is not exhaustive.  Local affiliates are named in parentheses; office locations are bracketed.

US or UK-based firms with offices in Brazil.

Several other deserve mention for significant work in Brazil and Latin America.  These firms do not have offices in Brazil.  This list is even more subjective.

Brazil is a hot place to invest–nem só eu que fala, é o jornalista estrangeiro que fala

Lines for the register in the grocery store often braid and cross each other here.  As a consequence, the man in front of me was waiting in two lines and looked a little confused.  I asked him in Portuguese which line he was in but he didn’t quite catch what I said.  Guessing that he might be a fellow foreigner, I switched to English and we struck up a conversation.

He turned out to be a journalist from Forbes researching the investment climate here in Brazil.

He asked me what I was doing here.  I explained that I am a law student from the US studying at PUC-Rio and launched into my Brazil pitch: the Why Brazil Question that I have been turning over in mind ever since I first visited in 2006.

In the next week, I’ll answer that question for the blog.  The general answer is that Brazil enjoys a diverse and growing economy and is well-position to thrive in a very tough global climate.  The demand for high-end legal services provided by American attorneys will expand along with the economy.  Yet relatively few young attorneys with language skill are targeting the Brazilian market.  And even fewer US law students like me are coming to Brazil to study for a semester alongside Brazilian law students, intern at firms run by Brazilian attorneys and develop contacts here.  Each of these activities has huge potential upside, especially if it positions you to work on Brazil-US transactions.  As lots of people on Wall Street and in Detroit know better than I do, it’s better to be in a growing market, than a shrinking one.

Plus I like the culture and speaking Portuguese.